Tether - How to Correct Deficiencies in Reporting on Reserves and Simultaneously Set Boundaries

So You'll Have to Read the Post Below

The central premise and promise of Tether is that it will maintain the value of its “stablecoin” at US$ 1 for each tether in circulation.

As outlined in previous posts, there are gaps in the information Tether provides that a careful investor would require to evaluate this promise.

1. The strategy that Tether applies to maintain this “stability” so that an investor could check whether that strategy is appropriate. As noted in this post, Tether has not explicitly done this and from the composition of the reserves I find it hard to believe their strategy is fully appropriate.

2. Sufficient periodic disclosure so that an investor could confirm that Tether is adhering to the promised strategy. As noted in this second post, Tether’s current disclosure of its “reserves” is insufficient to enable this. What were the NYS AG thinking when they set the disclosure requirements for reserves in the settlement agreement?

On the other hand, one could make the argument that someone who buys Tether is not a careful investor but rather a speculator or punter. So any information is likely to be ignored.

Or that the best strategy for careful investors is to avoid any investment in Tether. 

If you want a stablecoin backed by the US dollar wait until the UST issues one.

But let’s presume that this information would be useful to some investors. 

Equally it would also set boundaries within which Tether would have to operate. Perhaps, very advisable given past questionable stewardship of the reserves.

Now as we all know and will be told by cryptocurrency aficionados that one of their main reasons for investing in sh*tcoins is that one certainly can’t trust the government.

That same skepticism should be directed to non-governmental entities, especially a party with Tether’s track record.

How do we implement those information requirements? And not just for Tether?

Here’s a suggested minimum standard model: Fidelity’s Money Market Fund SPRXX.

The prospectus and monthly fact sheet set forth the fund’s objectives and strategy.

An investor would therefore have the information necessary to make a determination whether that strategy is appropriate.

Each month Fidelity discloses each of the holdings in the fund.

It also issues a semi-annual and annual audited financial report with that same information. You can access those here.

Similar reports on holdings from Tether would allow an investor to check whether the promised strategy is being adhered to.

As a holder of a stablecoin, wouldn’t you like to have a commitment as to what are the permitted asset classes, issuers, obligor credit ratings, tenors, concentrations, use of derivatives, etc. that your money can be “parked” in?

So you know if your money is on deposit with Oz at Crypto Capital in Panama or with HSBC London? Or invested in less liquid instruments?

Wouldn’t you also like to check periodically to make sure that the commitment was being adhered to?

Apparently the answer to both questions is no.

The February settlement agreement with the NYS AG had little impact on Tether.

As of 31 March the value of outstanding Tether was some US$ 42 billion.

In early June some US$ 62 billion.

There is as they say no vaccine for stupidity.

Tether: How Stable Are This Stablecoin’s “Reserves” ?

If You're Buying "Stable"coins, You Should Be
Reasonably Certain the Reserves are "Stable"

The 3 June FT Lex Column had a call-out box on Tether “Stablecoins/bitcoin: unTethered to reality”.

Citing information published by Tether, Lex noted that only 2.94% of the value of outstanding Tethers is backed by pure cash.

The remainder is “backed” by a variety of instruments:

• commercial paper (49.6%),

• short term deposits (18.36%),

• Treasury Bills and reverse repo notes (4.96%)

• secured loans (12.55%),

• corporate bonds, funds, and precious metals (9.96%), and

• other investments (1.64%), which include “digital tokens”

No real disclosure on the other items, except that “secured” loans weren’t to affiliates.

The lack of disclosure is troubling as will be discussed in the next post.

Lex dryly noted that not all of Tether’s reserves were held in risk free assets.

Indeed!

That directly impacts stability.

If the reserves are subject to volatility, then so is the value of the “stablecoin”.

So much for the “stable” in “stablecoin”.

But there’s a bit more here to think about.

This is quite a diverse set of assets.

1. What is Tether’s overall investment objective and strategy? It sure doesn’t look like “preservation of capital”.

2. How does this collection of assets achieve the objective and strategy?

3. What are the required criteria for investments, e.g., asset class, industry, individual investor or counterparty characteristics (credit grade, etc), tenor, etc?

4. Is Tether’s management capable of designing, executing, monitoring, and adjusting the strategy and portfolio as needed? They are by all accounts either certified tech geniuses or perhaps self-certified tech geniuses. But are they really financial geniuses as well?

5. If not, is Tether using third parties? If so, how are these selected?

6. Who are they? Goldman Sachs or Oz at Crypto Capital in Panama? What additional risk do these third parties pose in addition to obligor and counterparty risks?

7. Given the “diversity” of assets in the reserves, it might also be worthwhile to ask if any of these were used to purchase Tether. That is, has a customer or have customers bought Tether with any of the “reserve” assets rather than with cash.

8. If you’ve read paragraph 38 of the settlement agreement with the NYS AG, you’ll notice that in October 2018 Bitfinex “repaid” US$ 400 million in loans from Tether via the “redemption of 400 million tethers”. That is, via a non cash transation. It doesn’t seem likely that these were clients’ Tethers, assuming no sketchy dealing by Bitfinex. So were they Bitfinex’s own Tethers? And, if so, how did it obtain them?

It the next post we’ll look a bit more into other issues surrounding the valuation of the reserves.

CryptoCurrencies – The Manifest Absurdity of the Stablecoin

 

Just the other day, there was an article in the FT about "stablecoins" describing them as a "link" between traditional curriencies and cryptocurrencies.

There is quite a lot of manifest absurdity in the world these days, economics, politics, and matters financial.

To set the stage for today's exploration, a review of the "logic" for cryptocurrencies.

Proponents argue that:

1. Government-issued currencies are not "backed" by real assets. e.g., gold.

2. Governments can therefore issue as many "fiat" currency notes as they wish. Thus eroding value via inflation.

3. Electronic payments made with "fiat" currencies are subject to (a) surveillance and (b) seizure by pressumably intrusive and untrustworthy governments.

Cryptocurrencies are the "answer" because:

1. They are created by private sector entities and thus free from the "malign" behaviour of governments.

2. A key assumption (delusion) here is that private sector entities' honesty is beyond question.

3. While like fiat currencies cryptocurrencies are not backed by real assets, their value depends on and is obtained through the operation of the market.

4. A key assumtion (delusion) here is that the "market" never misvalues an asset either because of irrational exuberance, manipulation, market failure, etc.

5. Electronic payments made with cryptocurrencies are immune to (a) surveillance and (b) seizure by those presumably malign and untrustworthy governments.

6. A key assumption (delusion) is that movement via a trading platform from "fiat" currencies to "cryptocurrencies" and vice versa is not subject to (a) surveillance and (b) seizure by untrustworthy and malign governments.

7. Elliptic a blockchain/crypto security company claims to have traced Colonial Pipeline's ransom payment to a BTC wallet to which apparently other such payments were directed. And then payments out of that wallet.  Another delusion hits the wall.

So now to the "stablecoin"

1. Having trashed "fiat" currencies as unreliable and potential unstable, some stablecoins offer the investor the proposition of indirectly holding "fiat" currencies, e.g. tether.

2. In such cases, the stablecoin claims to hold one unit of fiat currency for each unit of cryptocurrency. So let's get that straight. It's backing its "currency" with the "real" asset of a "fiat" currency. But with the holder of the stablecoin assuming the risk of the intermediary between the Central Bank issuer of the fiat currency.  

3. Some stablecoins are tied to bitcoin or other sh*tccoins. Exactly how the underlying volatility of those "assets" is managed is no doubt a combination of "naive belief", "magic", and derivatives. The latter being the last (valuation) refuge of scoundrels and conmen.

4. Some stablecoins can in the words of Celsius pay interest 100X what one can earn in the bank market for fiat currencies. As of August 2020, capable of earning up to 16% per annum!

5. A key assumption (delusion) is that such returns make economic sense from investing in a non-productive asset. At least Tesla has a "real" business selling emission credits to third parties, even though that market appears to be shrinking!

So let's look a bit closer at the first class of stablecoins – those "tethered" to a fiat currency.

As background, here's a link to the settlement agreemen effective 18 February 2021 between the NY State Attorney General and iFINEX INC., BFXNA INC., BFXWW INC.,TETHER HOLDINGS LIMITED, TETHER OPERATIONS LIMITED, TETHER LIMITED, TETHER INTERNATIONAL LIMITED.

The pattern of behaviour recorded in the settlement agreement should demonstrate the fallacy of several of the assumptions (delusions) cited above.

It should also demonstrate the additional risk that such entities face in obtaining the services of creditworthy financial institutions.

When one is forced to deal in the “odd and out of the way corners” of financial markets, with undercapitalized institutions in less than ideal jurisdictions, including non banks, one’s business is subject to greater risks.

And those risks ultimately flow to the “wise” investors who have placed their funds with “one”.

Bitfinex is a cryptocurrency trading platform that allows its clients to trade between fiat and cryptocurrencies.

Tether is a stablecoin which claims to hold one US dollar in reserves for each “tether” issued.

It is by most accounts the “largest stablecoin in the cryptospace”!!!!

The companies are related parties.

Initially, Bitfinex and Tether worked through banks in Taiwan that had correspondent relationships with Wells Fargo Bank. In early 2017 WFB stopped processing transactions for Bitfinex and Tether.

In June 2017 Bitfinex opened an account with Noble Bank International Puerto Rico.

NBI was formed under Act 273 of Puerto Rico which provides for the creation of offshore financial entities. Such entities enjoy tax benefits and may not offer services to residents of Puerto Rico. They must have a minimum capital of US $5 million of which US $250 thousand must be paid in, and four employees.

Just the sort of financial “institution” one might think a good place to plunk down US $500 million of one’s “spare” change. Or more precisely one's customers' hard earned money.

Tether for its part kept its US dollar reserves at the Bank of Montreal but the account was in the name of its attorney.

Presumably, that was because BoM didn’t want to “entertain” an account from Tether.

Until September 2017, Tether (or more precisely its attorney) held some USD 61 million in that account. At that point some 442 million tethers (worth US $442 million) were in circulation. 

Even without a calculator you should be able to determine that the "collateral" coverage was less than 1 to 1.

During that time Bitfinex held US $382 million of Tether’s funds in its account.

After 15 September Tether opened an account at NBI and Bitfinex transferred the funds to Tether’s account.

Between 2018 and 2019, Bitfinex had problems finding an FI willing to handle its transactions.

So it turned to Crypto Capital in Panama to hold its funds.

By 2018 CC held some US $ 1 billion of Bitfinex's funds or more accurately its customers' funds.

No doubt it sounded like a great idea to plunk down US $1 billion in a non bank.

What could possibly go wrong?

Bitfinex's contact there was "Oz Yousef" or just "Oz".

I'd hasten to add that it's not clear from the settlement agreement whether Oz was a wizard or not.

Oz responded to Bitfinex's subsequent requests for its funds with a variety of excuses as to why the funds couldn't be moved.

Bitfinex nevertheless continued to direct new clients to remit funds to CC!

Apparently when you've got a guy like Oz handling your money, you can't let a few bumps in the road disturb the relationship.

During the summer of 2018, Bitfinex "borrowed" US $ 400 million from Tether.

Oz still was holdiing on to CC's money.

The two entities relationship with NBI was terminated and funds shifted to Deltec Bank Bahamas.

Bitfinex repaid Tether's initial US $400 million "loan" by redeeming an equal amount of Tethers.

Oz still wasn’t releasing Bitfinex’s funds.

2 November 2018 Tether remitted US $475 million from its account at Deltec Bank to Bitfinex’s account at Deltec bringing the total “loan” to some US $ 625 million.

In February 2019 Tether updated its website to state that “[e]very tether is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, ‘reserves’).”

Tether did not announce that it had changed its disclosure, and indeed there were no media reports about the change until several weeks later on March 14, 2019.  

It also did not provide a breakdown of its "reserve" holdings which would have shown that the bulk of these were in the form of loans to Bitfinex.

Subsequently, Bitfinex and Tether agreed a “credit” agreement under which Bitfinex could “borrow” up to US 900 million of Tethers funds (the supposed reserves for Tether). This appears to be part of a “regularization” on an existing US $625 million existing loan.

As of the date of the settlement agreement, Oz still hadn’t released any of Bitfinex’s cash or as noted above more precisely Bitfinex’s customers’ cash.